Standard deviation strategy

Markets tend to be very efficient. This is a statement that you will hear repeatedly, and there is a good reason for this as there tends to be steady moves over longer-term charts. Unfortunately, most people don’t look at the longer-term charts and tend to get stuck into the trap of trading short-term charts. Having said all of this, one of the best ways to trade financial markets is when they become inefficient, or move too far, far too fast.

This is where standard deviation comes in. On the attached EUR/CHF chart, you can see that the standard deviation indicator at the bottom of the chart is dialed into the 20-day exponential moving average. I would draw your attention to extreme low that was formed in June, and of course the extreme high that happened during the same day. As this happened, you can see that the standard deviation indicator spiked, and this would be your indication that the markets are out of whack. As we approached the top of the candle, it would have been time to sell, just as when we approach the bottom of the candle it would’ve been time to buy. You can see that most of the chart has been relatively calm, with a slightly negative bias. Every time the market spikes, the indicator rises slightly. By watching out for extreme moves in the standard deviation indicator, you can take advantage of the market that is acting irrationally, which is something that they don’t do very often.

The EUR/JPY pair pictured in the chart below was a little bit different, in the sense that the standard deviation had spiked, and then slowly turned around. This is a sign of a market that is running out of momentum. We had gotten too far ahead of ourselves, and you can see that the pair has since drifted lower. In this sense, you could have used the standard deviation strategy to tell you when it was time to get out. Once we got to the extreme highs of the indicator, you would have known that odds favored the market pulling back, if not falling for those lofty heights.

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